Coffee economics

Coffee prices boom & bust: a historical perspective

Viewed from a distance – from Jupiter, say – the coffee industry of planet Earth may appear to be a cheerful phenomenon of growth, ever onward and upward. But the global forest is one thing, the regional plantations quite another. Perspectives  also diverge within the various sectors of the industry’s value chain, and among speculators as well. To coffee growers, traders, roasters and retailers – as well national policymakers – the industry is rarely consistent and predictable. Charts that describe production in various regions can look as jittery as the EKG of a patient enduring cardiac arrest. Not that everybody thinks this is a bad thing – certainly not commodity traders. “Volatility helps the business as customers look to hedge or punt,” explains Kona Haque, a commodity specialist with Macquarie Bank in London. “But it does make my role in predicting prices quite tough!” Boom and busts are facts of life in the coffee industry. Heavy rain, harsh frost, disease, political turmoil, gyrating markets – all pose risks that must be addressed for businesses to succeed. Volatility may be an evergreen topic, but interest in it also intensifying – one reason the International Coffee Organisation recently hosted a conference expressly to discuss strategies for coping with all the ups and downs. Coffee has long been the world’s second most traded commodity, after petroleum. Today, business decisions are further complicated by what the Financial Times calls a “super-cycle” of investor interest in commodities. Investors who don’t care to drink coffee still want it in their portfolio – or they want to short it – affecting costs across the industry day by day. And beyond these questions, the threat of climate change looms as a wild card for the long term. “There is no question that the coffee market has changed, and may never again return to the levels that we considered normal just a couple of short years ago,” says Jay Isais, Senior Director of Coffee and manufacturing at the Coffee Bean & Tea Leaf. “ We will need to remain flexible and resourceful to develop new strategies that are fair to the producers and the roasters alike.”  To put it another way, normal volatility has now become abnormal volatility. “The unfortunate part,” Isais continues, “is that volatility and the level of the coffee market is now influenced by global investment activity, rather than the direct transactions of growers and roasters. This makes for a very uncertain environment for all of us in the industry.” Europe’s economic wrangling was cited in a 13 December report to investors by commodity analyst Rob Kurzatkowsk. He wrote: “Coffee futures continued their slump due to an increasingly negative bias toward food commodities. The recent exuberance seen in the equity markets may be coming to the end in the wake of the seemingly inevitable downgrades of France and Germany.” And at a recent conference in Ho Chi Minh City, industry forecasters warned that global coffee production will decline by 4 per cent in 2012, while consumption is expected to remain resilient. While acknowledging some “worry” about production, Roberio Oliveira Silva, Executive Director of the International Coffee Organisation, expressed confidence that consumption would continue to rise despite the broader globally economic turbulence, with Russia and China representing growing markets. Silva told Reuters he expect global consumption to equal the 2.5 per cent increase of 2009, the 2.5 per cent annual average growth seen in the past decade. “Consumption is going to be very well despite the economic turbulence,” he says. Speculators may be viewed with disdain industry players, but they weren’t the source of  trouble that befell Juan Valdez, the proud, mythic symbol of Colombia’s coffee growers. Valdez, it could be said, is still recovering from the epic coronary he endured from a confluence of trouble pummelled the country’s Arabica production at the turn of the century. Columbia’s troubles started with unfortunate timing. Swathes of groves were being rejuvenated with new plantings – a strategic decision that would temporarily hold down the yield. Then came heavy rains and disease that was exacerbated by the wet weather – and all in the midst of a recession. While Colombia’s farmers struggled, growers in Guatemala and Kenya benefited from the increase demand for their premium Arabica. Underscoring the regional aspect of booms and busts, Colombia’s hard times represented opportunity and profits for growers as far away as Kenya. A few years earlier, though, it was Colombia that profited from a damaging frost in Brazil. While Colombia went bust, Vietnam was booming with a Robusta crop fertilised by World Bank loans. While Vietnam would supplant Colombia as the world’s No. 2 coffee producer, Vietnamese growers (and the World Bank) would also be faulted for creating an oversupply that dropped the cost of coffee to crisis levels. Meagre profits were blamed for a downward cycle of lower quality and lower pay for workers. One constant amid the volatility, perhaps, is that the greatest uncertainty and risk lies with the growers. Nestor Osorio, who is now Colombia’s ambassador to the United Nations, described the ripple effects in a 2002 report titled “The Global Coffee Crisis: A Threat to Sustainable Development.” At the time, Osorio was the Executive Director of the International Coffee Organisation. “The coffee industry in developed countries is generally perceived as prosperous and uncontroversial.” Osorio observed. “But, although the coffee business is booming in consuming developed countries, current rock bottom prices are causing immense hardship to countries where coffee is a key economic activity, as well as to the farmers who produce it.” Today, coffee prices are near record highs. But a decade ago, the global demand was growing at 1.5 per cent, while supply was growing by 3.6 per cent – a glut attributed not only to Vietnam but also to a record yield in Brazil. The price of coffee had then fallen to about 50 cents a pound, “the lowest in real terms for 100 years,” Osorio noted. In the early 1990s, earnings by coffee producing countries ranged from US$10 billion to US$12 billion, derived from retail sales of US$30 billion. But during this crisis period, earnings by producing nations had fallen to US$5.5 billion even though retail sales had soared above $70 billion. And the amount of earnings that went to farmers from the sale of a typical cup of coffee at a coffee shop “is probably less that 2 per cent,“ Osorio said. In recent months, coffee prices have been hovering at high levels, with the New York C market for Arabica hovering at about US$2.30. Growers still face the usual risks from weather and disease, but the cost of premium specialty beans from Sumatra and Colombia in recent months have been priced at about US$1 more per pound than New York C market price for Arabica – about $2.30 per pound at time of writing, or double-to-triple the historic differentials. This puts more pressure on roasters and retailers to find ways to hold down the cost to consumers or risk losing their business. Coffee’s volatile nature creates headaches throughout the value chain. At one extreme are growers in poor countries where coffee is a leading export crop and a critical element in the nation’s economy as a major source of employment. Trouble in these regions can create desperation. During the past crisis, Osorio noted the move from coffee to alternative crops that “may include proscribed drugs like coca…. In Colombia, coca plantations can now be found in coffee areas.” Rock-bottom prices for growers also meant that workers were paid less and more likely to move into cities. In Guatemala, the harvest labour force was reduced from 500,000 to 250,000 for the 2001/02 crop.  At the most dire extreme, there were reports of indebted coffee farmers in India committing suicide, and others in Mexico who abandoned farms. Some died in the desert trying to illegally enter the US. More typically, however, growers find ways to cope. Farmers who would normally send pickers into fields three times per season to pick only ripened cherries would instead instruct them to pick them all at once, ripe or not. This reduced upfront costs but degraded the quality and depressed the price.
Nations whose economies are heavily reliant on coffee have generally stepped up efforts to provide educational, financial and technological support from growers. But Colombia’s crisis illustrated that even countries with a highly developed coffee industry can have problems. The country’s dependency on coffee is such that the government would commit US$150 million to helping Juan Valdez recover. While farmers are subject to nature’s caprice, players up the value chain have more ready alternatives to react to market conditions. Roasters and retailers can opt to replace pricey premium Arabicas with lesser beans – one of the industry’s dirty little not-so-secrets that are not advertised to consumers. “Coffee is fungible, so companies can change their blends when these things happen,” explains one industry insider who ask not to be identified. “It’s unlikely roasters will want to go on the record saying that they deliberately downgraded the quality of their coffee.“ A lowering of quality may alienate consumers with discriminating palates, but perhaps not those who order something like a macchiato with extra whip. Meanwhile, many big-name roasters and retailers have learned that long-term contracts with growers are a key to providing stability for the industry as a whole. CBTL, for example, has established long-term commitments with some suppliers at a fixed price to minimise the impact of fluctuations on the open market. “Our first priority across all market conditions is to secure an adequate physical supply of top quality coffees from each country.” Isais  explains. “We do this by careful forecasting based on our product mix and expected growth, and then work with our core group of suppliers to put in supply agreements and contracts to cover those specific physical needs. We have been extremely fortunate to have very reliable suppliers.” But the ability to strike long-term deals, insiders say, is now being complicated by the growing roles of commodity investors. And looming in the future is the uncertain impact of climate change, with predictions of more erratic and extreme weather patterns. In Haque’s view: “Climate change is yet to be confirmed. But, certainly the recent bouts of La Nina  and El Nino have had major impacts on production and yields and quality in the last few seasons for a variety of producers.“ And while Vietnam has been stockpiling Robusta, the global picture shows that coffee stocks over all are at  uncomfortably low levels. “The fact that stocks globally are at historically lows just means that any supply disruption as we have seen has a greater than normal impact on prices and volatility in genera,” Haque says. “But futures markets are increasingly being influenced by speculators, who in turn are taking cues from the global macro economic uncertainty.” Perhaps, then, only one thing about the future of the coffee industry is clear: it’s sure to be volatile. 

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